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Borrowing constraints and protracted recessions

Keiichiro Kobayashi and Masaru Inaba

Discussion papers from Research Institute of Economy, Trade and Industry (RIETI)

Abstract: This paper shows that some of the puzzling observations in the protracted recessions of the 1990s in Japan and the 1930s in the United States can be accounted for by a simple variant of the neoclassical growth model with borrowing constraints. There are three puzzles: First, a large wedge emerged between the marginal rate of substitution between consumption and leisure and the marginal product of labor. This labor wedge is associated with declines in labor inputs. Second, although shrinkage of investment was observed in both episodes, a wedge that represents investment frictions did not emerge. Third, in spite of unprecedented monetary easing in Japan since the late 1990s, deflation has continued. A key ingredient is the emergence of a huge accumulation of nonperforming debts, which must have been a consequence of the large fluctuations in asset prices. The debts tighten the borrowing constraints and can cause the puzzling features of the recessions, which may be protracted if the bad debt problem persists for years.

New Economics Papers: this item is included in nep-mac and nep-sea
Date: 2006-03
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